Many thanks to our Franchise, Distribution & Global Brand Expansion colleagues Abhishek Dubé, Kevin Maher, and Will Woods for co-authoring this post.
Massachusetts’ independent contractor statute applies to the franchisor-franchisee relationship and is not in conflict with the franchisor’s disclosure obligations under the FTC Franchise Rule (the “FTC Rule”), according to the Massachusetts Supreme Judicial Court’s decision on March 24, 2022 in Patel v. 7-Eleven, Inc., No. SJC-13166, 2022 WL 869486 (Mass. Mar. 24, 2022) answering a certified question from the US Court of Appeals for the First Circuit. What does this mean for franchisors in Massachusetts? They cannot rely on required compliance with the FTC Rule to exempt them from Massachusetts’ independent contractor statute (G. L. c. 149, § 148B) and ensuring their franchisees do not cross the line to “employee” status when Massachusetts’ independent contractor ABC Test is applied.
The Franchisees’ Argument, Massachusetts’ ABC Test and the FTC Franchise Rule
7-Eleven franchisees filed suit in Massachusetts Superior Court, alleging they were 7-Eleven employees instead of franchisees, and that they were misclassified as independent contractors in violation of Massachusetts’ independent contractor statute, as well as the Massachusetts’ wage act (G. L. c. 149, § 148) and minimum wage law (G. L. c. 151, §§ 1, 7). On the one hand, the franchise agreements classified the plaintiffs as independent contractors, and instead of receiving a “regular salary” under the agreements, each plaintiff could draw pay from the store’s gross profits after paying various fees required by the franchise agreement to 7-Eleven for the privilege of doing business with it. Patel v. 7-Eleven, Inc., 8 F.4th 26, 28 (1st Cir. 2021). On the other hand, the plaintiffs were “obligated to operate their convenience stores around the clock, stock inventory sold by 7-Eleven’s preferred vendors, utilize the 7- Eleven payroll system to pay store staff, and adhere to a host of other guidelines.” Id.
The case was removed to the US District Court for the District of Massachusetts. The judge allowed summary judgment in favor of 7-Eleven, concluding that Massachusetts’ independent contractor statute did not apply to franchisee-franchisor relationships because there is an “inherent conflict” between the independent contractor statute and the FTC Rule. Patel v. 7- Eleven, Inc., 485 F. Supp. 3d 299, 309 (D. Mass. 2020). The plaintiffs appealed, and the US Court of Appeals for the First Circuit certified the question to the Massachusetts Supreme Judicial Court, asking whether the three-prong test for independent contractor status set forth in Massachusetts’ independent contractor statute applied to the relationship between a franchisor and its franchisee where the franchisor must also comply with the FTC Rule, and noting the apparent conflict between the Commonwealth’s independent contractor statute and the so-called “exerting control” prong of the FTC Rule.
Massachusetts’ ABC Test
The Court found the Massachusetts’ independent contractor statute does not limit “employees” to include only individuals under the control and direction of a would-be employer. Instead, the statute allows a presumption that an individual “”performing any service” for a putative employer is considered an “employee” for purposes of the wage statutes. (G. L. c. 149, § 148B.)
Once the individual has shown the performance of services for the putative employer, the alleged employer can rebut the presumption by establishing each of the following three prongs by a preponderance of the evidence (known as the “ABC test”):
- the individual is free from control and direction in connection with the performance of the service, both under the individual’s contract for the performance of service and in fact;
- the service is performed outside of employer’s usual course of the business; and
- the individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.
If the alleged employer fails to show any one of these criteria, the individual is an employee for purposes of Massachusetts’ wage statutes (and entitled to the protections provided by them), but the first prong–the “free from control and direction” prong–was the one particularly at issue in the certified question.
The FTC Franchise Rule
The Court described the FTC Rule as not concerning employee misclassification, but instead a rule requiring pre-sale disclosure to combat deception in the sale of franchises, including misrepresentations related to the costs to purchase a franchise and the terms and conditions under which a franchise would operate. A franchisor’s failure to provide presale disclosures proscribed by the FTC Rule to a prospective franchisee is considered an unfair or deceptive act or practice in violation of section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45(a)(1), and the FTC Rule prohibits a franchisor from making unilateral, material alterations to the terms and conditions of the franchise agreement without providing timely notice to the franchisee.
The Court noted that under the FTC Rule, the disclosure requirements apply to, among others, “franchisors,” including “any person who grants a franchise and participates in the franchise relationship.” 16 C.F.R. § 436.1(k). And a “franchise” is a continuing commercial relationship where, inter alia, the franchisor “will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation.” 16 C.F.R. § 436.1(h)(2).10. As such, according to the Court, under the FTC Rule, a franchisor triggers required disclosures when it elects either (i) to exert a significant degree of control over the franchisee’s method of operation, or (ii) to provide significant assistance in the franchisee’s method of operation.
The Court: No Conflict Between the “Free from Control and Direction” Prong of the ABC Test and the FTC Rule
The Court found there was nothing in the statutory construction or the legislative intent of the independent contractor statute to exempt the franchise relationship from the ambit of Massachusetts’ independent contractor statute-application of the criteria for identifying independent contractors.
The Court also found there was no conflict between the first prong of Massachusetts’ ABC test and the FTC Rule, pointing out:
- The FTC Rule is a pre-sale disclosure rule that does not regulate the substantive terms of the franchisor-franchisee relationship.
- A franchisor does not need to exercise any particular degree of control over a franchisee to comply with the FTC Rule’s disclosure requirements. Rather, the FTC Rule establishes rules for when the franchisor chooses to exercise a certain degree of control.
- Disclosure requirements under the FTC Rule can be triggered even without the franchisor exercising any control over the franchisee’s method of operation if the franchisor provides “significant assistance” in the franchisee’s method of operation.
“The Two Tests Are Not the Same”
The Court also addressed the certifying court’s concern that a franchisor electing to exercise a “significant degree of control over the franchisee’s method of operation” might not be able to show that the individual is “free from control and direction in connection with the performance of the service” under the first prong of Massachusetts’ ABC Test. However, the Court stated that even where the franchisor makes that election, the FTC Rule’s disclosure obligations do not negate proper classification of employees under the independent contractor statute. Instead, a franchisor can comply with the FTC Rule to make the prescribed disclosures, and in situations where a franchisee is deemed an employee under the independent contractor statute, the franchisor can also comply with its obligations under the wage statutes.
But the Court was careful to highlight that the franchisor’s election to exercise “a significant degree of control over the franchisee’s method of operation” does not make every franchisee an employee under the first prong of the ABC Test, because the two tests are not the same: “control over the franchisee’s method of operation” does not require a franchisor to exercise “control and direction” in connection with the franchisee’s “performing any service” for the franchisor, which is the relevant inquiry under the first prong of Massachusetts’ ABC Test. The Court emphasized “significant control” over a franchisee’s “method of operation” and “control and direction” of an individual’s “performance of services” are not necessarily coexistent.
And in response to 7-Eleven’s argument that applying the ABC test to franchise relationships would result in all franchisees being employees under the ABC Test, the Court noted that the court and courts in other jurisdictions had previously applied the ABC Test to franchising relationships, “yet franchising continues in the Commonwealth.” Patel v. 7-Eleven, Inc., No. SJC-13166, 2022 WL 869486, *24.
Patel is not the end for Massachusetts franchisor-franchisee relationships, but does provide some pointed guidance. If franchisors are careful to craft and implement franchise agreements without directing and controlling how the franchisee performs services, franchisors that have more typical structures should be able to maintain a proper franchisor-franchisee relationship and avoid becoming inadvertent employers–or coming within the ambit of the Massachusetts wage law and wage act.
The Court provided some “[a]dditional guidance,” which included a couple of “take home” points:
- Nothing in the independent contractor statute prohibits legitimate franchise relationships among independent entities that are not created to evade employment obligations under the wage statutes, but referencing the Attorney General’s fair labor and business division Advisory 2008/1 at 5, the Court highlighted that “[t]he difficulty arises when businesses are created and maintained in order to avoid the [independent contractor statute].”
- Distinguishing between legitimate arrangements and misclassification requires examination of the facts of each case, beginning with a threshold determination whether the putative employee “perform[s] any service” for the alleged employer–which is not satisfied merely because a relationship between the parties benefits their mutual economic interests, and is not satisfied by required compliance with federal or state regulatory obligations in isolation.
Under any standard, an accidental misstep could have the unintended consequence of converting a franchisee into an employee. Franchisors in Massachusetts and elsewhere should work with counsel to review both their franchise agreements and implementation and supervisory practices to avoid inadvertent conversion of a franchise relationship into an employment one.